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5. Allocation and Depreciation of Differences Between Implied and Book Values Acquisition. Advanced Accounting, Third Edition. Learning Objectives. Calculate and allocate the difference between implied and book values to the subsidiary’s assets and liabilities.
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5 Allocation and Depreciation of Differences Between Implied and Book Values Acquisition Advanced Accounting, Third Edition
Learning Objectives • Calculate and allocate the difference between implied and book values to the subsidiary’s assets and liabilities. • Contrast the past accounting (under GAAP) and proposed accounting for bargain acquisitions. • Explain how goodwill is measured at the time of the acquisition. • Describe how the allocation process differs if less than 100% of the subsidiary is acquired. • Record the entries needed on the parent’s books to account for the investment under the three methods: the cost, the partial equity, and the complete equity methods.
Learning Objectives • Prepare workpapers for the year of acquisition and the year(s) subsequent to the acquisition, assuming that the parent accounts for the investment using the cost, the partial equity, and the complete equity methods. • Understand the allocation of the difference between implied and book values to long-term debt components. • Explain how to allocate the difference between implied and book values when some assets have fair values below book values. • Distinguish between recording the subsidiary depreciable assets at net versus gross fair values. • Understand the concept of push down accounting.
Allocation of Difference Between Impliedand Book Values: Acquisition Date • Allocation of difference between implied and book values at date of acquisition. • Step 1: Difference used first to adjust the individual assets and liabilities to their fair values on the date of acquisition. • Step 2: Any residual amount: • Implied value > aggregate fair values = goodwill. • Implied value < aggregate fair values = bargain. In a bargain acquisition, some acquired assets are reduced below their fair values. LO 1 Computation and Allocation of Difference (CAD)
Allocation of Difference Between Impliedand Book Values: Acquisition Date • Bargain Rulesunder prior GAAP (before 2005 proposals): • Acquired assets, except investments accounted for by the equity method, are recorded at fair market value. • Previously recorded goodwill is eliminated. • Long-lived assets (including in-process R&D and excluding long-term investments) are recorded at fair market value minus an adjustment for the bargain. • Extraordinary gain recorded if all long-lived assets are reduced to zero. LO 2 Current and proposed treatment of bargain acquisitions.
Allocation of Difference Between Impliedand Book Values: Acquisition Date Bargain Rules:Under exposure draft (ED) of the Financial Accounting Standards Board, “Business Combinations,” No. 1204-001, issued June 30, 2005, the negative (or credit) balance should be recognized as an ordinary gain the year of acquisition. Under this proposal, no assets should be recorded below their fair values. LO 2 Current and proposed treatment of bargain acquisitions.
Allocation of Difference Between Impliedand Book Values: Acquisition Date Review Question In the event of a bargain acquisition (after carefully considering the fair valuation of all subsidiary assets and liabilities) the most recent FASB proposal requires the following accounting: • an ordinary gain is reported in the financial statements of the consolidated entity. • an ordinary loss is reported in the financial statements of the consolidated entity. • negative goodwill is reported on the balance sheet. • assets are written down to zero value, if needed. LO 2 Current and proposed treatment of bargain acquisitions.
Allocation of Difference Case 1: Implied Value “in Excess of” Fair Value E5-1On January 1, 2007, Pam Company purchased an 85% interest in Shaw Company for $540,000. On this date, Shaw Company had common stock of $400,000 and retained earnings of $140,000. An examination of Shaw Company’s assets and liabilities revealed that their book value was equal to their fair value except for marketable securities and equipment: LO 4 Allocation of difference in a partially owned subsidiary.
Allocation of Difference E5-1A. Prepare a Computation and Allocation Schedule for the difference between book value of equity acquired and the value implied by the purchase price. LO 4 CAD Schedule for less than wholly owned subsidiary.
Allocation of Difference E5-1(variation) Prepare the worksheet entries to eliminate the investment, recognize the noncontrolling interest, and to allocate the difference between implied and book. Common stock 400,000 Retained earnings 140,000 Difference between Implied and Book 95,294 Investment in Shaw 540,000 Noncontrolling interest in Equity 95,294 Marketable securities 25,000 Equipment 20,000 Goodwill 50,294 Difference between Implied and Book 95,294 LO 4 Allocation of difference in a partially owned subsidiary.
Allocation of Difference Case 2: Acquisition Cost “Less Than” Fair Value E5-1 (variation)On January 1, 2007, Pam Company purchased an 85% interest in Shaw Company for $470,000. On this date, Shaw Company had common stock of $400,000 and retained earnings of $140,000. An examination of Shaw Company’s assets and liabilities revealed that their book value was equal to their fair value except for marketable securities and equipment: LO 4 Allocation of difference in a partially owned subsidiary.
Allocation of Difference E5-1(variation) Prepare a Computation and Allocation Schedule. LO 4 CAD Schedule for less than wholly owned subsidiary.
Allocation of Difference E5-1(variation) Prepare the worksheet entries. Common stock 400,000 Retained earnings 140,000 Difference between Implied and Book 12,941 Investment in Shaw 470,000 Noncontrolling interest in Equity 82,941 Marketable securities 25,000 Equipment 20,000 Gain on acquisition 27,250 Noncontrolling interest in equity 4,809 Difference between Implied and Book 12,941 LO 4 Allocation of difference in a partially owned subsidiary.
Effect of Allocation and Depreciation of Differences on Consolidated Net Income: Year Subsequent To Acquisition When any portion of the difference between implied and book values is allocated to depreciable and amortizable assets, recorded income must be adjusted in determining consolidated net income in current and future periods. Adjustment is needed to reflect the difference between the amount of amortization and/or depreciation recorded by the subsidiary and the appropriate amount based on consolidated carrying values. LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4On January 1, 2007, Porter Company purchased an 80% interest in Salem Company for $850,000. At that time, Salem Company had capital stock of $550,000 and retained earnings of $80,000. Differences between the fair value and the book value of the identifiable assets of Salem Company were as follows: The book values of all other assets and liabilities of Salem Company were equal to their fair values on January 1, 2007. The equipment had a remaining life of five years. The inventory was sold in 2007. Year of Acquisition LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4Salem Company’s net income and dividends declared in 2007 and 2008 were as follows: 2007 Net Income of $100,000; Dividends Declared of $25,000; 2008 Net Income of $110,000; Dividends Declared of $35,000. Entries recorded on the books of Porter to reflect the acquisition of Salem and the receipt of dividends for 2007 are as follows: Investment in Salem 850,000 Cash 850,000 Cash 20,000 Dividend income ($25,000 x 80%) 20,000 Year of Acquisition LO 4 CAD Schedule for less than wholly owned subsidiary.
Consolidated Statements – Cost Method P5-4A. Prepare a Computation and Allocation Schedule Year of Acquisition LO 4 CAD Schedule for less than wholly owned subsidiary.
Consolidated Statements – Cost Method P5-4B. 1.Prepare the worksheet entries for Dec. 31, 2007. Dividend income ($25,000 x 80%) 20,000 Dividends declared 20,000 Beg. retained earnings - Salem 80,000 Common stock - Salem 550,000 Difference between Cost and Book 432,500 Investment in Salem 850,000 Noncontrolling interest in equity 212,500 Year of Acquisition LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4B. 1.Prepare the worksheet entries for Dec. 31, 2007. Cost of goods sold 40,000 Land 65,000 Plant and equipment 130,000 Goodwill 197,500 Difference between cost and book 432,500 Depreciation expense ($130,000/5) 26,000 Plant and equipment 26,000 Year of Acquisition LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4C. 1.Prepare the worksheet entries for Dec. 31, 2008. Salem 2007 income $100,000 Salem 2007 dividends declared - 25,000 Total 75,000 Ownership percentage 80% $ 60,000 Investment in Salem 60,000 Beg. Retained Earnings ‑ Porter Co. 60,000 To establish reciprocity/convert to equity as of 1/1/2008 Subsequent Year LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4C. 1.Prepare the worksheet entries for Dec. 31, 2008. Dividend income ($35,000 x 80%) 28,000 Dividends declared 28,000 Beg. retained earnings - Salem 155,000 Common stock - Salem 550,000 Difference between Cost and Book 432,500 Investment in Salem 910,000 Noncontrolling interest in equity 227,500 Subsequent Year LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4C. 1.Prepare the worksheet entries for Dec. 31, 2008. 1/1 Retained Earnings – Porter 32,000 Noncontrolling interest 8,000 Land 65,000 Plant and equipment 130,000 Goodwill 197,500 Difference between cost and book 432,500 1/1 Retained Earnings – Porter 20,800 Noncontrolling interest 5,200 Depreciation expense ($130,000/5) 26,000 Plant and equipment 52,000 Subsequent Year LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4D.Prepare a consolidated financial statements workpaper for the year ended December 31, 2009. Although no goodwill impairment was reflected at the end of 2007 or 2008, the goodwill impairment test conducted at December 31, 2009 revealed implied goodwill from Salem to be only $150,000. The impairment has not been recorded in the books of the parent. (Hint: You can infer the method being used by the parent from the information in its trial balance.) Subsequent Year LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4 D. 2009 Year Subsequent of Acquisition Subsequent Year LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4 D. 2009 Year Subsequent of Acquisition Subsequent Year LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4D.Explanations of worksheet entries for Dec. 31, 2009. Acquisition date retained earnings - Salem $ 80,000 Retained earnings 1/1/09 - Salem 230,000 Increase 150,000 Ownership percentage 80% $ 120,000 Investment in Salem 120,000 Beg. Retained Earnings ‑ Porter Co.120,000 To establish reciprocity/convert to equity as of 1/1/2009 Subsequent Year LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4D. Worksheet entries for Dec. 31, 2009. Dividend income ($60,000 x 80%)48,000 Dividends declared 48,000 Beg. retained earnings - Salem 230,000 Common stock - Salem 550,000 Difference between Cost and Book 432,500 Investment in Salem 970,000 Noncontrolling interest in equity 242,500 Subsequent Year LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4D. Worksheet entries for Dec. 31, 2009. 1/1 Retained Earnings – Porter32,000 Noncontrolling interest8,000 Land 65,000 Plant and equipment 130,000 Goodwill 197,500 Difference between cost and book 432,500 Subsequent Year LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Cost Method P5-4D. Worksheet entries for Dec. 31, 2009. 1/1 Retained Earnings – Porter(2 years)41,600 Noncontrolling interest (2 years)10,400 Depreciation expense ($130,000/5)26,000 Plant and equipment 78,000 Impairment loss ($197,500 - $150,000)47,500 Goodwill 47,500 To record goodwill impairment Subsequent Year LO 4 Allocation of difference in a partially owned subsidiary.
Consolidated Statements – Partial and Complete Equity Methods The equity methods (partial and complete) reflect the effects of certain transactions more fully than the cost method on the books of the parent. However consolidated totals are the same regardless of which method is used by the Parent company. LO 5 Recording investment by Parent, partial equity method. LO 5 Recording investment by Parent, complete equity method.
Additional Considerations Relating to Treatment ofDifference Between Implied and Book Values Allocation of Difference between Implied and Book Values to Debt Notes payable, long-term debt, and other obligations of an acquired company should be valued for consolidation purposes at their fair values. • Quoted market prices are the best. If unavailable, then management’s best estimate based on • debt with similar characteristics or • valuation techniques such as present value. LO 7 Allocating difference to long-term debt.
Additional Considerations Relating to Treatment ofDifference Between Implied and Book Values Allocating the Difference to Assets (Liabilities) with Fair Values Less (Greater) Than Book Values On the date of acquisition, sometimes the • fair value of an asset is less than the amount recorded on the books of the subsidiary. • fair value of long-term debt may be greater rather than less than its recorded value on the books of the subsidiary. LO 8 Allocating when the fair value is below book value.
Additional Considerations Relating to Treatment ofDifference Between Implied and Book Values Allocating the Difference to Assets (Liabilities) with Fair Values Less (Greater) Than Book Values E5-1(Variation)On January 1, 2007, Pam Company purchased an 85% interest in Shaw Company for $540,000. On this date, Shaw Company had common stock of $400,000 and retained earnings of $140,000. An examination of Shaw Company’s assets and liabilities revealed that their book value was equal to their fair value except for marketable securities and equipment: LO 8 Allocating when the fair value is below book value.
Allocation of Difference Cost Method E5-1A. Prepare a Computation and Allocation Schedule for the difference between book value of equity acquired and the value implied by the purchase price. LO 8 Allocating when the fair value is below book value.
Allocation of Difference Cost Method E5-1 (variation)At the end of the first year, the workpaper entries are: Marketable securities 25,000 Goodwill 90,294 Difference between Implied and Book 95,294 Equipment 20,000 Equipment,net 4,000 Depreciation expense ($20,000 / 5 years) 4,000 Note: the overvaluation of equipment will be amortized over the life of the asset as a reduction of depreciation expense. LO 8 Allocating when the fair value is below book value.
Allocation of Difference Cost Method E5-1 (variation)At the end of the second year, the workpaper entries are: Marketable securities 25,000 Goodwill 90,294 Difference between Implied and Book 95,294 Equipment 20,000 Equipment, net 8,000 Beg. retained earnings - Pam 3,400 Noncontrolling interest in equity 600 Depreciation expense ($20,000 / 5 years) 4,000 LO 8 Allocating when the fair value is below book value.
Allocation of Difference Reporting Accumulated Depreciation in Consolidated Financial Statements as a Separate Balance E5-7On January 1, 2008, Packard Company purchased an 80% interest in Sage Company for $600,000. On this date Sage Company had common stock of $150,000 and retained earnings of $400,000. Sage Company’s equipment on the date of Packard Company’s purchase had a book value of $400,000 and a fair value of $600,000. All equipment had an estimated useful life of 10 years on January 2, 2003. Required: Prepare the December 31 consolidated financial statements workpaper entries for 2008 and 2009, recording accumulated depreciation as a separate balance. LO 9 Depreciable assets at net and gross values.
Allocation of Difference E5-7Prepare a Computation and Allocation Schedule. LO 9 Depreciable assets at net and gross values.
Allocation of Difference Cost & Partial Equity Method E5-7 Prepare the December 31 consolidated financial statements workpaper entries for 2008 and 2009. Equipment 400,000 Accumulated depreciation 200,000 Difference between Implied and Book 200,000 Depreciation Expense ($400,000/10) 40,000 Accumulated Depreciation 40,000 LO 9 Depreciable assets at net and gross values.
Allocation of Difference Cost & Partial Equity Method E5-7 Prepare the December 31 consolidated financial statements workpaper entries for 2008 and 2009. Equipment 400,000 Accumulated depreciation 200,000 Difference between Implied and Book 200,000 1/1 Retained Earnings -Packard Co. 32,000 1/1 Noncontrolling interest 8,000 Depreciation Expense ($400,000/10) 40,000 Accumulated Depreciation 80,000 * Complete equity method: debit to 1/1 Retained Earnings – Packard Co. would be replaced with a debit to Investment in Sage Company LO 9 Depreciable assets at net and gross values.
Allocation of Difference Disposal of Depreciable Assets by Subsidiary In the year of sale, any gain or loss recognized by the subsidiary on the disposal of an asset to which any of the difference between implied and book value has been allocated must be adjusted in the consolidated statements workpaper. Depreciable Assets Used in Manufacturing When the difference between implied and book values is allocated to depreciable assets used in manufacturing, workpaper entries may be more complex because the current and previous years additional depreciation may need to be allocated among work in process, finished goods, and cost of goods sold. LO 9 Depreciable assets at net and gross values.
Push Down Accounting Push down accounting is the establishment of a new accounting and reporting basis for a subsidiary company. The valuation implied by the price of the stock to the parent company is “pushed down” to the subsidiary and used to restate its assets (including goodwill) and liabilities in its separate financial statements. LO 10 Push down of accounting to the subsidiary’s books.
Push Down Accounting Arguments for and against Push Down Accounting Three important factors that should be considered in determining the appropriateness of push down accounting are: • Whether the subsidiary has outstanding debt held by the public. • Whether the subsidiary has outstanding a senior class of capital stock not acquired by the parent company. • The level at which a major change in ownership of an entity should be deemed to have occurred, for example, 100%, 90%, 51%. LO 10 Push down of accounting to the subsidiary’s books.
Push Down Accounting Status of Push Down Accounting As a general rule, the SEC requires push down accounting when the ownership change is greater than 95% and objects to push down accounting when the ownership change is less than 80%. In addition, the SEC staff in SAB No. 54 expresses the view that the existence of outstanding public debt, preferred stock, or a significant noncontrolling interest in a subsidiary might impact the parent company’s ability to control the form of ownership. In these circumstances, push down accounting, though not required, is an acceptable accounting method. LO 10 Push down of accounting to the subsidiary’s books.
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